Income: should you hang up on Vodafone

Neil Woodford’s decision to sell out of Vodafone is a bold one and although this puts him in a minority in the equity income sector, he is not alone in falling out of love with the telecom giant.

The Invesco Perpetual star finished exiting the position last week with the move, coming the day after the company’s trading update, raising eyebrows.

Although Vodafone reported revenues fell by 5.2% in the fourth quarter, the market was cheered by the fact the company did not cut its growth forecasts and its shares rose by over 2% on the day.

However, Woodford, a long-term backer of the stock, believes it is a company in decline.

Invesco Perpetual director Mitchell Fraser-Jones says: ‘The company has reduced its forecasts for revenue growth on the back of ongoing weakness in its core southern European markets and the cash flow cover of the dividend has fallen to what we view as uncomfortably low levels.

‘The company announced a share buy-back rather than the hoped for special dividend with its dividend from Verizon Wireless, while we also have reservations about the company’s ability to maintain its margin on data revenues.’

Telecom sector under pressure

Clive Beagles and James Lowen, co-managers of the JOHCM UK Equity Income fund, have been long-term bears, arguing Vodafone and the wider sector face heavy capital expenditure requirements at a time when revenues are increasingly coming under pressure, putting pressure on dividend cover.

Lowen admits the sector is ‘cheap, but with negative fundamentals’ and says the pair believe Vodafone is in ‘dangerous territory’ in terms of the structural risks it faces.

Both Woodford and the JOHCM pair’s call to zero weight the stock is out of step with their peers, with Vodafone a staple in the top 10 holdings lists of a vast number of UK equity income funds.

The fact it is so widely held is little surprise given it is a chunky 5.1% of the FTSE 100 index and the fourth largest stock by market capitalisation.

Paying a healthy dividend yield of 5.67%, it has long been a sector stalwart, including in Woodford’s Income and High Income funds until last week.

Positive trends

Artemis’s Adrian Frost, Jupiter’s Tony Nutt and M&G’s Alex Odd are among the well-known managers with significant positions in the telecom firm and PSigma Income manager Bill Mott is another fan with a 5.9% overweight holding.

‘Our main theme here is the positive trends towards increased use of bandwidth in the internet age and the explosion in data usage, but we also think that these areas will prove to be relatively robust in a high inflation/low growth scenario,’ Mott says.

‘We believe that we have got to the stage where people regard their mobile phone as an everyday essential.’

Analyst consensus backs this view with 28 out of 32 analysts tracked by Reuters rating the company either hold, outperform or a buy and just one rating Vodafone a sell.

But that said, the number saying it is a buy has almost halved from three months ago, dropping from 11 to six, over which time the share price has risen by only 2.5%.

Whether Woodford’s call proves right remains to be seen, but one thing that is certain is that his investable universe keeps on shrinking.

He sold out of the utilities sector, which makes up 3.9% of the FTSE 100, completely in 2011 citing regulatory risk and his latest call means there is almost a tenth of the market that he will not touch with his £21 billion Income and High Income funds.

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